What is trade finance?
Trade finance can best be viewed of as a sub-set of the loan market. It is relatively short-term loans used to finance the physical flow of goods, using those goods as the primary source of collateral within the loan.
How is our approach to trade finance different?
The Federated Hermes approach to trade finance is different than what we see in the market, based upon two main factors. One is the type of loans that we’re doing. We typically co-invest with banks in the very like large – I’d say ‘bankable’ – end of the trade finance market. So, within a corporate trade loan, our typical borrower is doing a US$500m to US$1.5bn loan. These are companies with an average US$1bn-plus EBITDA and leverage ratios of one to maybe three times. So, these are large loans to big companies that have very healthy balance sheets.
The second key differentiator is diversification – and we take that very seriously. We diversify on multiple factors. One is just underlying borrower size and position size. Our typical position size will be under 1% of the portfolio. We diversify geographically, in regions and countries, by sector and subsector, and by the types of trade finance loan structures that we invest in. So, a lot of other trade finance products in the market are going to be concentrated on one specific part of the trade finance market, but we invest in both the supply-chain-finance-type of transactions, financial institution loans, corporate loans, a little bit of project finance and loans to sovereigns.
How does your strategy ensure a steady pipeline of top-tier deals?
We source deals from large global financial institutions, large banks, and development financial institutions (DFIs). Right now, we have about 40% of our transactions sourced from European banks, 30% from American banks, and the remainder from regional banks such as Japanese banks and African banks. What we are doing is we are partnering with banks in these trade finance transactions – for banks, this is an ‘originate-to-hold’ not an ‘originate-to-distribute’ model, it’s a primary business of commercial banks. They’re holding a significant portion of these loans on their balance sheets so that we are investing with them. We don’t see ourselves as a bank disintermediation product. We’re not taking the place of banks. We’re working with banks.
Both the art and science of analysing one of these transactions is to identify what are the risks inherent in this transaction and how can we mitigate those risks or hedge them to acceptable levels.
How does the team navigate risks?
An interesting aspect of the trade finance market is that these are loans that facilitate the physical flow of goods. But what we’re lending to is a specific trade flow or asset conversion cycle not to a company for general corporate purposes. So, both the art and science of analysing one of these transactions is to identify what are the risks inherent in this transaction and how can we mitigate those risks or hedge them to acceptable levels. We look at risk on three different factors: credit risk, structure risk and macro risk. There are ways to mitigate risk – each one of those types of risk. However, because each transaction is a bespoke financing, there’s no typical way to do it. But all of those risks can be identified and mitigated by various techniques.
What are the wider benefits of the strategy?
In the Western world, we often think of imported goods as luxury items. For the vast majority of the world, they’re the essential goods. It’s the energy that heats their home in the winter, it’s the food that they eat. So going as far back as the global financial crisis, a lot of the official community – the World Trade Organisation, the IMF – did a lot of studies that showed that the type of trade finance we are doing – the securitised, collateralised, risk mitigation, trade finance – were the types of transactions that kept these essential goods flowing around the world. So even though overall economic activity decreased, and overall trade flows decreased during the financial crisis, it was these types of transactions that kept those essential goods flowing. We saw the exact same type of relationship during the Covid-19 pandemic and the supply chain disruption it caused. So, again, it was this part of the trade finance market that kept these essential goods flowing around the world.
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